Last autumn a new management team took the helm with the aim of establishing the company as a specialist asset management group focused on managing funds and co-investments across a range of differentiated and illiquid alternative investment strategies. I was impressed by the strategic direction of the new board, led by chief executive Tony Dalwood, the former boss of Schroder Ventures before he established SVG Investment Managers, so I recommended buying into the shares a few weeks ago when the price was 320p (‘A sound mandate for growth’, 12 October 2015).
Since then the company has made its first acquisition, that of Aitchesse, an asset manager focused on forestry and timber assets. Founded in 2002 by its current chairman Digby Guy, Aitchesse has increased assets under management by 400 per cent to £192m since 2007, helped by a favourable market for commercial forestry. In fact, in the past decade UK forestry has shown an annualised return of 18.8 per cent, with no years of negative returns, according to the IPD UK Annual Forestry Index. This compares favourably with UK equities (6.8 per cent annual return), UK bonds (6.3 per cent) and commercial UK property (6.2 per cent). It's worth noting that the price of timber has risen by almost 11 per cent on average in the same 10-year period, so the investment gains reaped in part reflect the positive pricing environment.
It's fair to assume that global demand for timber will remain strong, driven by demographic changes - the world's population is set to rise by 500m to 7.5bn in the next five years alone; the increase in biomass legislation is putting huge demand on wood resources; global economic growth; and material substitution: legislation favours a preference for low carbon building materials.
At the same time, the UK is a net importer of wood products and is likely to remain so given the need to step up new building starts due to the chronic housing shortage in parts of this country. As a result, the pricing and investment backdrop remains favourable both domestically and overseas for asset managers focused on forestry and timber assets. There are tax advantages too in the UK as all income from timber sales is tax-free, investment gains are free from capital gains tax, and after two years of ownership commercial forestry becomes inheritance tax exempt.
Sensibly financed deal
Moreover, it's a highly profitable niche business as Aitchesse reported pre-tax profits of £946,000 on revenue of £2.27m in the 12 months to end-June 2015. A third of turnover came from arrangement fees on assets purchased (typically between 2 per cent and 2.5 per cent of the transaction value), with the balance made up of asset management fees.
It looks a sensibly priced deal to me: the initial consideration of £4m payable is made up of £1.8m of cash, £670,000 of short-term loan notes and £1.5m of shares priced at 298.5p, based on the last reported net asset value at the end of June 2015. Importantly, the vendors have an equity interest in Gresham House, so there is an added incentive to expand the business further to reap further financial gains and benefit from an earn-out that could pay as much as £3.7m. This payment is made up of £1.5m of cash and £2.2m of shares, the exact amount dependent on Aitchesse delivering on a sliding scale cash profits in a range between £1.7m and £3.4m in the period from July 2015 to February 2018.
This is a useful income stream and adds to the annual management fee income of £579,000 Gresham House's newly formed specialist asset management (GHAM) arm is earmarked to earn from its first mandate win with Aim-traded Gresham House Strategic (GHS: 850p). I commented on this in my October article ahead of GHAM receiving authority from the Financial Conduct Authority to provide investment management services. Confirmation of FCA approval was announced today and GHAM has been appointed the investment adviser to Gresham House Strategic with immediate effect.
Substantial asset backing
Importantly, Gresham House has ample legacy assets it can dispose of in order to fund further bolt-on acquisitions to scale up its business. It's making headway here too.
For instance, seven weeks ago, the company received an initial payment of £944,610 from Persimmon (PSN:1,901p) after selling 25.8 acres of land at Newton Le Willows, a market town in Merseyside, for a total consideration of £7.25m. The balance of the consideration is payable in three tranches over the next 40 months. The company still retains a five-acre site with retail planning permission bordering the Newton Le Willows residential site, and which has been valued at £2.25m by Jones Lang LaSalle. The board is exploring options for the disposal of this legacy asset.
I also understand that Jones Lang LaSalle has recently valued the company's legacy property in Speke, Liverpool, known as Southern Gateway, a multi-let office and industrial complex, at £7.6m. Around 295,000 sq ft of the 375,000 sq ft of the mixed industrial and office space is let out to 14 tenants and generates £783,679 in annual rent. And with lease agreements now in place on the remaining space too, Jones Lang LaSalle has been appointed to advise the company on selling the development.
The bottom line is that Gresham could potentially reap gross proceeds from the balance of the Persimmon land sale, the five-acre site at Newton Le Willows, and Southern Gateway, of £16.15m. That's a significant sum in relation to its market value of £31m. Furthermore, to free up some of the cash held up in these three assets, and repay its current bank debt of £2.85m with the Co-operative bank and the £667,000 short-term loan notes being issuing to the vendors of Aitchesse, the board is in negotiations with two banks regarding a new bank facility of £7m carrying an interest rate of 5.25 per cent. It has received a credit committee approved letter from both institutions. This means half the balance of the £7m new loan will be available for further investment opportunities.
Cashed up for further acquisitions
So by my reckoning, Gresham House's pro-forma net asset value of £30.2m post the Aitchesse acquisition and entering the £7m new loan agreement, consists of: property assets worth almost £10m; deferred consideration from Persimmon of £6.3m; £13m of cash balances; Gresham House Strategic shares worth £5.8m (I commented on this in my last article); and unlisted investments of £2.2m. That's rock solid asset backing in my view.
Also, in terms of those unlisted investments I would point out that Gresham House is due £1.23m of deferred consideration from its interest in one of its legacy investments, a private company that sold a former Royal Mail sorting office in Edinburgh to CALA Management in mid-June this year. This cash is expected to be received in 2016. It also has around £900,000 invested through loan notes and equity in a company that owns a 55-acre cemetery in Chislehurst in the London borough of Bromley.
In other words, Gresham House has ample cash available to develop both its strategic equity and real estate asset management businesses. Shareholders will have the right to have a say in this as a general meeting will be held on 20 November to approve the acquisition and a share incentive scheme for management, which I feel is fair. I expect them to vote through the motions overwhelmingly, and with further deals on the horizon I feel buying into the Gresham House story at this early stage has clear potential to reap healthy long-term rewards.
Priced on a modest 13 per cent premium to book value, and offering 30 per cent upside to my initial target price of 450p, I continue to rate Gresham House's shares a buy on an offer price of 345p.
Please note that I have written two other columns today, both of which are included in the list below.
MORE FROM SIMON THOMPSON...
I have published articles on the following companies in the past two weeks:
■ MS International: Buy at 180p, initial target price 240p ('Making waves', 19 October 2015)
■ Pure Wafer: Buy at 175p, new target 200p ('Valuation anomaly worth exploiting', 20 October 2015)
■ Greenko: Hold at 87p, new target 100p ('Greenko's cash return', 20 October 2015)
■ Elegant Hotels: Buy at 108p, target range 130p to 135p ('An elegant investment', 20 October 2015)
■ BP Marsh & Partners: Buy at 157p, target 180p ('Cash-rich value play', 21 October 2015)
■ Crystal Amber: Buy at 170p; Dart Group: three month trading buy at 468p; Grainger: three month trading buy at 247p; Leaf Clean Energy: await news on Invenergy asset sale ('A quadruple play', 22 October 2015)
■ UTV Media: Buy at 184.5p, target 215p ('On the right wavelength', 26 October 2015)
■ Globo: shares suspended at 28p ('Globo bombshells', 26 October 2015)
■ Globo: shares suspended at 28p ('The truth about Globo', 29 October 2015)
■ Getech: Sell at 38p ('Getech warns', 3 November 2015)
■ Redde: Run profits at 178.5p; Trakm8: Run profits at 250p; 32 Red: Run profits at 95p; Manx Telecom: Run profits at 208p; Burford Capital: run profits at 189p ('Five companies that keep on delivering', 3 November 2015)
■ Gresham House: Buy at 345p, 12-month target price 450p ('Sowing the seeds for growth', 9 November 2015)
■ Inland: Run profits at 73p, initial target 80p ('Tapping into hidden value', 9 November 2015)
■ K3 Business Technology: Run profits at 361p ('In the money, 9 November 2015)
■ Simon Thompson's book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 and is being sold through no other source. It is priced at £14.99, plus £2.95 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stockpicking'
